Wages rise, but Latvia's shadow economy keeps growing

A study by SSE Riga shows that in 2025 Latvia's shadow economy reached 21.8% of gross domestic product, up 0.5 percentage points from the previous year. While estimates vary depending on methodology, the shadow economy continues to represent a substantial part of the national economy.

Envelope wages remain the core issue

According to the study, envelope wages account for 47.1% of the total shadow economy, making them its most significant component. Kārlis Purgailis explains that the highest risk is concentrated in small businesses, the services sector and construction — industries where it is harder to track the actual number of employees. The phenomenon can take the form of fully unregistered employment, where wages are paid entirely off the books, or partial underreporting, where only part of a worker's actual pay is officially declared.

Rising incomes have not changed behavior

Although household incomes in Latvia have grown over the past decade, the share of the shadow economy has not meaningfully declined — a decade ago it stood at 21.3% of GDP. This suggests that higher income alone is not enough to discourage undeclared payments, even though they reduce social guarantees, future pensions, and access to loans or leasing.

One factor sustaining the practice is the tax burden on labor. Latvia's base personal income tax rate is 25.5%, on top of which social insurance contributions are added. The larger the gap between what an employer pays and what an employee actually receives, the stronger the incentive to pay part of the wage unofficially — particularly in price-sensitive sectors such as construction.

Possible solutions

Some measures are already showing results: electronic working-time recording in construction and requirements for minimum mandatory social contributions have helped curb envelope wages in certain sectors. Broader digitalization and reduced cash circulation could further limit the practice, since unofficial payments are much harder to make electronically. However, the most sustainable long-term solution would be lowering the personal income tax rate, since Latvia currently has the highest base rate among the Baltic states.